FOMC Statement & Potential Impact on Fixed Income

Following the Fed’s announcement, please see below for market views from the Global Fixed Income, Currency & Commodities Team (GFICC):

Consistent with our and the market’s expectations, the Federal Open Market Committee (FOMC) increased the Fed Funds rate target range by 25bps to 2.00%‐2.25%.

The September FOMC statement maintained existing language reflecting the solid economic backdrop in the US, roughly balanced risks to the outlook and the appropriateness of further gradual rate hikes. The most interesting change was the reference to the stance of monetary policy, which was previously described as remaining accommodative, has been subsequently removed. This change further distances the Fed from the extraordinarily easy policy and explicit forward guidance used at the zero lower bound. The Fed statement did not reference the balance sheet but the process will continue in the background. We expect more conversation about the future of the balance sheet run-off (which will hits the maximum run-down rate in October) to occur in the coming months.

Committee Statement

We can break the statement into three parts:

Economic Assessment – No change. The Committee maintained an optimistic assessment on growth and unchanged language on inflation.

Outlook – No change. The Committee expects sustained growth, strong labor market conditions and inflation to meet their objective while continuing with further gradual increases in the Federal Funds rate.

Forward Guidance – The FOMC continues to remove residual language relating to the ultra-easy monetary policy used during the crisis and early recovery. By removing the language that policy remains accommodative, they are also acknowledging the uncertainty around estimates of the natural rate of interest and how many more rate hikes are appropriate in this hiking cycle. Going forward, the Fed will be data dependent, in tune to how financial conditions react to further tightening or policy as well as inflation and inflation expectations. In our opinion, these changes should be viewed as an end to the FOMC Statements forward rate guidance regime in this cycle.

There were no dissenters. Richard Clarida, the new Vice Chair of the Fed, voted for the first time at this meeting.

Summary of Economic Projections

Investors had priced in nearly 100% probability of a rate hike at this meeting, so the SEPs and the “Dot Plot” took on greater importance. Within the projections, the growth forecasts were modestly upgraded. The inflation forecasts were mostly unchanged. The median forecast of core PCE continues to show a small overshoot above the Fed’s target in 2019 & 2020. The unemployment rate estimates were also mostly unchanged.

The median dots for 2018 remained unchanged reflecting a total of 4 hikes, but the dispersion around this forecast declined. The 2019 median dot was unchanged reflecting 3 additional rate hikes in 2019. The 2020 dot was unchanged reflecting 1 additional rate hike. A forecast for 2021 was added in which the median of the committee expected no change in the Fed Funds rate between 2020 and 2021. The long-run dots shifted up modestly from 2.875% to 3%.

Chair’s Press Conference

Chair Powell remains upbeat on the economic outlook and the progress the Fed is making at returning rates to a more normal level. Chair Powell also explicitly addressed the meaning of removing a sentence in the statement describing policy as accommodative. He stated it does not signal a change in monetary policy and it is a sign that policy is proceeding in line with expectations. Powell went through great pains to highlight the uncertainty of policy in the future as many fluid crosscurrents make precision on esoteric measures of slack, equilibrium rates and other unobservable factors less clear.

Our View:

The committee is intentionally reducing the length of the FOMC statements as their confidence increases and the market requires less forward rate guidance as policy move further away from 0%. The balance sheet will continue to progress in the background.

Evidence of further improvement on inflation toward and above the 2% objective and still easy financial conditions will keep the FOMC tightening at the current pace.

The change in the FOMC’s balance sheet has been widely publicized and well telegraphed and the knock-on impact to markets so far has been muted as the run-off remains minimal. We anticipate the run-off will continue well into 2019 however we expect the debate around the composition, weighted average maturity and end date of the run-off program to intensify in the coming months.

We expect that the reduction in global central bank liquidity in 2018 will move more into the market’s purview as the year progresses and could cause an increase in risk-asset volatility.

We expect the Fed will continue to gradually raise the Federal Funds rate again in December and at least two more times in 2019 as inflation moves gradually higher, financial conditions remain easy, labor markets continue to tighten, fiscal expansion continues and regulatory reform takes shape. This will allow 10-year Treasury yields to continue to trend higher in 2018 and into 2019.

The FOMC is at a critical junction and will need to make several important decisions in the coming quarters around its monetary policy framework and the size and future holdings of its balance sheet. These decisions will define how the Fed conducts monetary policy into the future and will have long last impacts on liquidity and the broader markets.

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